Fears grow in Ottawa that Bank of Canada hiked rates too soon

Officials within Prime Minister Justin Trudeau’s government are concerned the Bank of Canada is moving too quickly to raise interest rates, fearing higher borrowing costs could inadvertently trigger a downturn.

Governor Stephen Poloz raised the central bank’s key overnight rate this month for the first time since 2010, and another increase is expected by the end of the year. The officials, speaking anonymously because they’re not authorized to comment, are concerned a series of rate hikes would lead consumers to claw back spending, stunting a recovery from a two-year oil shock.

While Trudeau and Finance Minister Bill Morneau have steadfastly declined to comment on monetary policy, as is customary, some officials privately think Poloz hiked too soon. The concern comes amid global warnings that an era of rock-bottom interest rates has left consumers and countries alike over-leveraged and more vulnerable than ever to hikes.

There’s no sign the government will intervene publicly in any way. The discontent, however, signals Trudeau and Morneau also don’t plan to rein in a spending program, focused on infrastructure and payments to families, that’s projected to result in deficits totalling $102 billion over the Liberal government’s first four fiscal years.

“I do not comment on the Bank’s independent decision,” Morneau said in a statement this week. The government has “more work to do,” he said, hinting at unease with the current recovery. “As we look at our next steps, it’s clear we will move forward by continuing with an approach that’s working, always with a strong middle class and long-term economic growth as our goals.”

Rebecca Ryall, a spokeswoman for the Bank of Canada, declined to comment.

Household debt is at unprecedented levels in an economy that has relied mostly on consumer spending for growth since the 2008-09 recession. The central bank decided July 12 to raise borrowing costs against a backdrop of broadening disinflation that seemed to argue against such a move.

Household spending contributed 2.4 percentage points of the 3.7 per cent gross domestic product growth in the first quarter. That’s the largest contribution made by households since 2010.

In announcing the rate increase, policy makers said an acceleration in growth, and its broadening to more sectors and regions, has increased “confidence” the economy will continue to absorb excess capacity. The central bank estimates the economy will return to full capacity by the end of this year.

Red Ink

Economists expect the deficit to shrink as the economy kicks into high gear, and one official said the government also expects higher revenues to narrow the gap. However, calls have surfaced for Trudeau to begin balancing the books now that Canada leads the Group of Seven in GDP growth.

While Morneau has avoided commenting on the rate hike, he praises the growth that made it possible, which can be partly attributed to the government’s fiscal measures. “The fact that the economy is going well is a positive,” Morneau said at a July 18 press conference, where he acknowledged rising interest rates could slow consumer spending. “The changes in behavior would largely be around new purchases. That would be the most significant impact I would expect.”

Trudeau faces potential political fallout from any hike. Canada’s most indebted households overlap demographically with his base of support — higher debt servicing costs spell trouble for the poster-family of Trudeau’s first budget —and polling has shown Canadians aren’t immediately feeling the boom.

Indebted Families

That all underpins the officials’ concern. Canadians are uncharacteristically vulnerable to increases in rates because of high levels of debt, the officials said. Complicating forecasts is that an entire generation of young adults has grown up with the belief that money is essentially free to borrow and won’t adjust quickly enough, they said.

The scale of concern varies among the officials, who acknowledge Poloz may yet be proven right. If Canada is entering a sustained expansion, then growth will more than account for rising rates.

However, if Poloz’s timing is wrong and the hike triggers a pullback in consumer spending, Canada’s economy will be in trouble, the officials said. Low inflation and the strengthening of the Canadian dollar further indicate Poloz might have started a policy action that wasn’t needed, one official said.

Another wrinkle is the outlook for Alberta, the hub of Canada’s energy sector, where a recovery was seen as the final domino that led to a rate hike. However, persistently low crude prices and a rising currency —driven in part by Poloz’s rate increase —are a recipe for another slowdown in an oil sector whose revenues are largely derived in U.S. dollars, the officials said.